Why This Huge Gaming Company Is in Trouble

Investing in the gaming industry is a high-risk game where most investors find it hard to be consistently profitable. Just consider the case of Electronic Arts , down 50% since 2003. Of course, potential mind-boggling returns make this industry also hard to ignore.Activision Blizzard, the world's biggest video game publisher, is up an amazing 1800% in the same period. This is not surprising, considering the industry could be worth $70 billion by 2017. More and more children, youngsters and adults play video, mobile and computer games at home, on the train, after school or work and before sleeping. Gaming is changing the world.

However, after nine years of massive success, Activision Blizzard's cash cow, World of Warcraft, is losing subscribers very quickly. Furthermore, with little exposure to mobile and social gaming, the firm is losing share against smaller publishers and even outsiders, like Electronic Arts and Disney. We may be witnessing the beginning of a huge power shift in the gaming industry. How does Activision Blizzard plan to protect its leading position in the gaming industry?

Source: Activision Blizzard

A blockbuster-producing companyThe gaming industry is said to be a hit-or-miss business. Activision Blizzard is an exception. It successfully managed to produce not just one, but three massive hits: Call of Duty, World of Warcraft, and Skylanders.

Each of these games has a vibrant community of gamers. World of Warcraft has been the company's main cash cow for the past eight years. Skylanders and Call of Duty were developed later.

Although World of Warcraft saw its number of subscribers decrease from 12 million to 7.7 million, Skylanders and Call of Duty have plenty of room for growth. With retail sales of more than $1.5 billion, Skylanders Giants got the first ranking in North America and Europe in the first half of 2013, while Call of Duty: Black Ops II got the second place. Not surprisingly, Call of Duty digital sales record grew by more than 100% in the latest quarter.

Activision Blizzard's main competitive advantage is its ability to deliver great games for any console. The company also excels at developing rich intellectual property. Its team of dedicated developers and designers, with more than 20 years of experience in the field, keeps innovating game play. And management isn't afraid of setting aggressive marketing campaigns to support its games.

Fierce competitionHowever, as management also acknowledges, it's becoming more challenging to gain new gamers and retain old ones, because the industry is more crowded and competitive. On top of this, there's an ongoing console transition, which adds uncertainty to Activision Blizzard's revenue for the next two quarters.

As the second-largest game publisher, Electronic Arts (EA) is a formidable competitor. Just like Activision Blizzard, EA is famous for building high-quality games and rich intellectual property. But there are some important differences between these two giants.

First, Electronic Arts has specialized in the sports genre, a segment where Activision Blizzard has limited presence. EA's main cash cow is its Fifa soccer game series, which does not require constructing characters from scratch. In theory, this game can be popular forever, just like soccer. By focusing on providing a unique multiplayer gaming experience, Fifa has become a must-have for soccer and gaming lovers. Its last version netted $70 million in digital revenue last quarter. EA is taking advantage of the know-how it acquired from Fifa to successfully develop and promote other sports games.

EA has also done two important innovations this year. First, it has developed Sports Ignite, a state-of-the-art game engine designed specifically for sports titles, which could bring development costs down. Second, EA is changing its business model gradually, and it is adding more mobile exposure. The new version of Fifa may hit mobile devices with a free-to-play business model. It's too early to know how these changes will reflect on revenue, but they are promising.

Activision Blizzard's Skylanders, on the other hand, faces heavy competition from Disney's Infinity video game, where the user can play with some of Disney's most popular characters, like Mr. Incredible and Jack Sparrow, in an open world. Both games belong to the action-adventure genre, and have similar concepts and features, like using collectible characters. They are clear substitutes.

However, unlike Activision Blizzard, Disney does not have to create new characters from scratch. In 85 years of history, Disney has accumulated a rich library of popular characters, which are ready for use. So far, the game seems to be selling quite well. Last month, Disney announced the game had sold almost 300,000 copies in the U.S. only in the first two weeks on sale.

The Foolish takeawayActivision Blizzard has developed very successful game titles, including World of Warcraft, which holds the Guinness World Record for most popular multiplayer online role-play game by number of subscribers. However, the gaming landscape is constantly changing, and the company must keep innovating in order to protect its leading position. In particular, EA's recent mobile focus and advanced game engines, and Disney's Infinity video game should be watched closely.

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